Monday, November 2, 2015

"Of Trading and the Perfect Trader" (and Izabella still writes like a boy)

If you are in search of tips and techniques.

The headline is clickbait.
This post has nothing to do with trading as it is usually covered on this blog.

In fact, the title is a poor translation of "Della Mercatura et del Mercante Perfetto", the first known work on double entry bookkeeping.
I was thinking of ...del Mercante Perfetto's author, Benedetto Cotrugli, because in the post we are about to visit, Izabella Kaminska mentions the more famous proponent of the double entry, Luca Pacioli.

There's a simple reason Pacioli is more famous: he was a better communicator with a better system. As The Accountant's Magazine said in 1906: "Cotrugli may have been most estimable as a man of affairs, but as a writer he was an old woman".*
That is one harsh review.

By comparison, Pacioli's "Summa de arithmetica, geometria, proportioni et proportionalita", of which his distillation and memorialization of the "Venetian method" of bookkeeping is a part, is a work of art.
Here's a good translation.

With that rather meandering introduction here's Izabella at FT Alphaville:

Techies look upon the financial world and find its messy structures hard to reconcile with the physical reality around them.

Which is why we’re going to propose that the blockchain fad is mostly about puttingfinance in terms that are understandable to techies — i.e. as something absolute – and having them learn for themselves through trial and error why that’s actually a flawed assumption in finance.

Like their world, finance is full of numerical entries in databases, which are theoretically costless to replicate and propagate. Logically, like Lady Gaga MP3s, these entries should have no real-world value because people can’t be trusted to not steal, share or replicate the data.

Yet, unlike their data world, in finance these numerical entries do retain value, and they do so mainly because — unlike Lady Gaga MP3s — there is a cost to oversharing the information. The more replicated money entries are the less useful they are to society. To the trust-suspicious techie who knows just how easy it is to share information on the internet or how to steal it, this might seem a naive way to store value in a digital era.

But money isn’t like a Lady Gaga MP3, which provides utility to the user irrespective of how extensively it is copied. Its value lies in its ability to balance the system by way of trusted and verified relationships.

Since the value of money is gone as soon as it is over-replicated, there’s only value in replicating it from the point of view of a hacker, a thief or a scammer if its copy somewhere else in the system can be erased.

The value of financial information consequently doesn’t lie in the data. It lies in the trusted relationship between the payee and the payer who promises to delete his copy of the unit — the counterfoil — as soon as the value is transferred.

Which is why in an effective financial network, simply copying information about an account holder isn’t valuable of its own accord. What’s valuable is persuading the network which guards or confirms the stake into thinking the copied information is legitimate, whilst the victim’s version is illegitimate. It’s about crediting one, whilst debiting the other. Most important of all, it’s about convincing the verifier to accept the illegitimate claim as the real one — much harder to do if there’s a manual back-up or if the verifier knows his customer extremely well.

But these sorts of trust relationships look like single points of failure to techies.
Which is why the bitcoin blockchain addresses value transfer not from a trusted checks and balances point of view, but by turning money into a scarce resource, which can’t be easily replicated. That’s not because the counterfoils are reliably destroyed within the system, but to the contrary because they are deemed to have no value unless they’ve been accepted as legitimate by at least 50 per cent of the network. And since it costs to verify, it costs to manipulate the network.

But what this really does is turn a relativistic system into an absolutist one.

In terms of value control it’s a bit like going back in time to the days of single-entry accounting — when merchants were only interested in tracing tangible assets across space and time, without any relativistic context.

As Luca Pacioli recognised in the 15th century it was the lack of relativistic balance in company accounts which compromised the ability of merchants to fully understand the value of their enterprises, exposing them to unexpected losses, frauds and errors.